The RBA’s next move: a different angle

If you didn’t listen to me, hopefully you followed George Soros’s rumoured move shorting the Aussie and picked up your share of the $60 million profit, as the RBA surprised the bulk of the economists and cut the cash rate 25 basis points to 2.75 per cent – a record low. Australia has finally joined the rest of the world at record low rates, but is there more to come?

Last week, the RBA felt it had enough ammunition in the gun and could choose to pull the trigger or not – it was a finely balanced decision. I (finally) got it right when they fired the rate cut cannons.

The initial noise was as deafening as the stunned silence afterwards. Less than two months ago, plenty of experts were saying that the next move was more likely to be up than down.

Most commentators, trying to justify their errors, were back-pedalling so hard they would put Michael Jackson to shame, and missed the absolutely critical part of the RBA’s statement:

“The Board has previously noted that the inflation outlook would afford scope to ease further, should that be necessary to support demand. At today’s meeting the Board decided to use some of that scope."

Now to me, “decided to use some of that scope" implies that the RBA still has some scope to cut further, i.e. there is still an easing bias.

I agree that this comment is not as strong as the previous easing bias found in April, March and February’s statement: “an accommodative stance of monetary policy is appropriate".

But the RBA hasn’t finished cutting yet – a fact that has been ignored by all but a few commentators.

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If domestic economic conditions don’t improve, we may still not get a cut next month but most probably a further drop in the cash rate will be forthcoming before the end of Q313. However, I would expect to see the words “an accommodative stance of monetary policy is appropriate" return to the RBA’s comments first.

The statement was also notable because the RBA viewed certain areas, such as China, as actually improving over the month.

I believe the real reasons the RBA cut were threefold:

Firstly on inflation, the RBA statement read: “Recent data on prices confirm that inflation is consistent with the target and, if anything, a little lower than expected."

Secondly, it appeared that the RBA was more aggressive in implicitly talking down the Australian dollar: “The exchange rate, on the other hand, has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates during that time."

Thirdly, and this was not mentioned in the RBA’s statement, is the budget situation, which means that we are going to see fiscal headwinds for the foreseeable future.

Where did all the news leave the futures markets? At the end of the week, swaps contracts indicated about a 50 per cent probability of an RBA cut in July and 75 per cent chance of a cut by September.

Interestingly this month, the three domestic majors (NAB, CBA and ANZ), the Bank of Queensland and Suncorp could not pass on the RBA cut quickly enough. What’s more it was the full 25 basis points; NAB, CBA and Westpac were out of the blocks faster than Usain Bolt. On Friday, ANZ upped the ante further with an above and beyond 27 basis points cut.

But the fact that the banks were so quick to pass on the full amount gives the casual observer all the information they need to know about the banks’ cost of funding, and how comfortable they really feel.

Prior to yesterday’s move the banks had passed on only 140 basis points out of the RBA’s 175 basis points of cuts, or about 80 per cent.

With that easing bias in mind, did Thursday’s employment data put a spanner in the works? Despite the possibility of an early Easter as an explanatory factor, the Australian employment figures of +50,100 (cons +11,000) provided a huge upside surprise, especially given the RBA’s decision to cut rates. Or was it?

My view is that the RBA would have seen the employment figures, or at least have had a very good idea what they would be. As such, the RBA still decided to cut rates. Why?

There are two possible explanations. Firstly, it may be that the RBA believes these figures are a blip or there are other seasonal factors to explain the strength away. The RBA may be looking over to Western Australia, where the unemployment rate increased to 5.2 per cent, the highest since 2009.

Secondly, consider this. What was the response of the Aussie dollar to the employment numbers? Unsurprisingly, it initially rallied. Maybe that gives us a bigger clue into the thinking of the RBA and we should move the importance of the high Australian dollar further up the pecking order of concerns for the RBA’s board.

Is the RBA now in the mindset that bad economic data leads to rate cuts to stimulate growth, whereas good economic data leads to an appreciating Australian dollar and more rate cuts to contain the currency’s rise?

There’s been a lot of post employment-number analysis that says the RBA is less likely to cut the cash rate but could the case be made for it to be more likely? Especially as the RBA seems to be unconcerned about inflation, highlighted in Friday’s Statement on Monetary Policy.

In summary, the RBA rate cut cannons may have been wheeled back into the Fort Denison’s gun room but the authorities may need to consider changing the daily firing times from 1pm to 2.30pm for the first Tuesday of each month; this rate cutting cycle isn’t over.

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